ARTHUR, ARTHUR

Right on cue, as though by magic, just when I was going to start putting down some thoughts about managing banks Arthur Levitt comes through with an op ed piece entitled Risk and Discipline in the Financial Markets in the Wall Street Journal today. Do you think Arthur is a reader of the blog? One wonders. Anyway, at one time you might remember that Mr. Levitt was the Chairman of the SEC (1993-2001) and now he is an advisor to Goldman Sachs, and not an unpaid one I am sure. Mr. Levitt served at the same time and in the same administration as Robert Rubin and both men at the time enjoyed extremely high reputations among their peers for reasons, quite frankly, which escaped me. One might remember that Mr Levitt oversaw the Great Dot Com. Boom...and bust...during which 16 year old analysts at the great Wall Street houses were pumping companies' stock prices into the stratosphere on the basis of...well, on basically no basis. Nevertheless, comes now Mr Levitt to explain to us, the Great Unwashed, how we can fix things going forward. (Full disclosure: I have no reason to be upset at Mr. Levitt. I put two kids through college buying and--fortunately selling--crap just in time). My future turned out not to be so bright, however.

Mr Levitt has focused on derivatives as being the cause of all sin in the world and especially unregulated derivatives traded OTC. Before that, however, Mr. Levitt concludes that we must eliminate the risk of Too Big to Fail hereinafter referred to as, "TBTF" in every instance in the future), and with that the related Too Interconnected To Fail" (TITF") which he attributes solely to an institution's involvement in unregulated and non-transparent derivatives markets. He correctly points out that there are in place unique protections for derivatives that complicate the winding up of a financial institution but to hold as he does that the solution is to standardize the creation and trading of instruments would solve the problem is naive to a fault. Mr. Levitt argues that institutions will gravitate to those marketplaces that offer the best protection against systemic risk: crap. I simply do not believe that any consideration of systemic risk enters into a trading decision on the part of any institution in the world. Systemic risk does not exist as a relevant concept until it occurs. Remember my definition? It is when everybody gets the crap scared out of them at the same time. Credit risk for individual institutions, yes. But systemic risk? That boys and girls is a concept best left to central banks to prevent and that NEVER can be done through regulation. It exists in the air, not on the ground and is created through the convergence of a series of factors, sometimes preventable but often not foreseeable until the very last moment. This is very hairy-fairy stuff and I want to get all my thoughts in order so we will follow up tomorrow. Stay with me.



Loyal reader Paul commented on the rise in the discount rate the other day by remarking that the rise was hardly enough. Paul, don't sweat the small stuff. If nobody is using the window what the hell difference does it make what the rate is? It was a meaningless gesture designed to test the reaction of the market. The Market reacted to the meaningless gesture as it always does; it ignored it. You should too. But thank you for reading and for your comments